What is Risk Management? The Basics You Need to Know
No matter which industry, every organization faces risk in some form. Risk management is the process of identifying, assessing and controlling risk factors that could cause the company harm, and minimizing the possibility of these risks occurring as well as their potential impact.
These risks can be quantifiable, such as financial risk that costs the company money, or subjective, such as damage to your company’s reputation. Risks can stem from various sources, ranging from natural disasters to legal liabilities. Risk management is the attempt to control these threats proactively, protecting the business from uncertainty.
What is risk analysis?
Risk events can be caused by both internal and external influences. Internal risks arise from decision-making, while external risks are caused by environmental conditions that your organization cannot influence (such as market conditions).
Risk analysis is the process of assessing the probability of an adverse event – such as a project’s failure. The process helps you identify and manage potential problems that could undermine your business objectives. The main reason to conduct risk analysis is to identify what could go wrong and then implement controls to reduce uncertainty to an acceptable level.
When done properly, risk analysis helps you understand the probability of achieving the outturn dates and costs; helps to Inform and influence decision-making; and helps show you the level of contingency required.
Risk analysis can be complex, but it can help you save valuable time and money in the long run.
Importance of risk management
So what are the benefits of having effective risk management? There are quite a few. Overall, it leads to a safe and secure work environment, improves the stability of your business, and protects your organization and staff from potential harm. How?
Spot risks that are not apparent
Comprehensive risk management practices can help you identify real risks that may not be obvious at first glance. By understanding the performance of individual projects, you can ensure your organization is spotting those that may be in trouble and stay on top of health checks, peer reviews, and audits.
Fewer surprises and better communication
When it comes to risk, nobody likes surprises. Catching potential problems early on means that the right people can intervene in a timely manner and mitigate risk. Managing risks before they materialize and necessitate firefighting makes your organization run smoothly and more efficiently.
Good risk management also elevates communication – it encourages conversation between key stakeholders and teams. It causes discussions about potential causes of conflict, which strengthens work relationships between teams.
Better decision-making and budgeting
Risk management allows you access to better data and helpful information, which in turn leads to better decision-making. This directly affects budgeting – contingency budgets can be estimated more accurately when you’re more aware of potential risks. Risk management essentially plays into cost planning and can help you avoid budgeting mistakes.
Risk management strategies and processes:
The first step in the risk management process is to establish the context, as this creates the criteria against which you will assess the risks. The scope should be laid out within your organization’s objectives. These objectives need to be set out clearly, as risks are the uncertainties that can affect achieving your business objectives.
Selecting your business objectives should be done by evaluating both internal and external factors that may impact your organization. Reviewing these at the beginning of your risk assessment planning helps you identify processes that may be subject to increased risks. These are the processes that will extract the most value from risk assessment.
Comprehensive identification of major risks is crucial for effective risk management. If you fail to identify a potential risk, it will be excluded from any further analysis and giving it an inadequate amount of attention could be disastrous. There are a few steps to effectively identifying risks:
1. Identify what could happen, and where and when it could occur
Based on the last step, establishing context, you need to come up with a list of potential risks that could interfere with achieving the business objectives you chose. Use qualitative terms to describe the risk even if it were to occur. Some phrases to start with are “failure to…” or “loss of…” but do not include the consequence of the risk, simply identify it. Ask yourself some questions to help you identity risk, such as:
- How could we fail?
- Where are we vulnerable?
- What could go wrong?
- How could someone disrupt our operations?
- How do we know whether we are achieving our objectives?
- What information do we rely on most?
- What do we spend the most money on?
- What activities are most complex?
2. Identify why and how it could happen
Now you need to consider the possible causes and consequences of each risk.
Identify potential triggers that could cause the risk to occur – a single identified risk might have just one cause, or it may have multiple. Different risks may also have the same single cause.
Now, identify the possible consequences of each risk event – again, a single identified risk might have just one consequence, or it may have multiple. Different risks may also have the same single consequence.
There are a few different techniques you can use for this step. You may opt to have ongoing risk identification, where anyone can identify risks, or you may want to consider desk-based risk assessment. The latter is a good option for fairly straightforward processes, and involves a discussion and assessment of risks with the people who are involved in the day-to-day operation of the selected process.
Risk analysis and assessment
Risks are basically uncertainties about outcomes. You need to consider how likely the risk event is to happen, and the possible extent of the consequences. Based on risk analysis, you assign a risk rating. The analysis usually involves:
- Analyzing inherent risks (what’s the likelihood and consequence of the risk event if it occurred in an uncontrolled environment?)
- Identifying and evaluating controls (what controls are in place to deal with the risk and how effective are they?)
- Analyzing residual risks (what’s the likelihood and consequence of the risk event if it occurred in the current environment?)
Risk assessment provides insight into key business risks and how they link to your organization’s objectives and processes. You need to develop the criteria by which you’ll assess risks – this is subjective, so it’s productive to have various stakeholders challenge each other. Let’s examine these steps in more detail:
Analyzing inherent risks
You conduct this analysis before looking at the controls that are already in place; this helps you understand the role of controls in reducing risk. For each risk, ask:
- How likely is the risk to occur if no controls were in place?
- What is the extent of the probable consequence if the risk were to occur with no controls in place?
Identifying and evaluating controls
Controls are any action you have in place that will reduce the likelihood or consequences caused by a risk event occurring. For each risk, ask:
- What is the existing control in place? This could be the process, policy or action that can be used to change the likelihood or consequences of the risk event. If there’s nothing in place, you have a control gap.
- How effective is the control? This includes its design and its operation.
Analyzing residual risks
This step is assessing the risk after controls are taken into consideration. For each risk, ask:
- How likely is the risk to occur within the current environment? This should be done after reviewing how effective the controls are.
- What is the most likely consequence of the risk event if it occurred in the current environment? This should assume that the controls are operating at the strength that is expected.
Based on these factors, you should come up with one overall risk rating for residual risks.
Treating risks means you need to come up with a range of options to mitigate the risks, assessing each of the options, and then creating and implementing action plans. Highest rated risks should naturally be addressed first.
To choose the right risk mitigation treatment, you need to do a cost-benefit analysis; take the wider context into account when judging this. Based on the nature of the risk, you have a few options:
To choose the right risk mitigation treatment, you need to do a cost-benefit analysis.
- Avoid the activity that causes the risk event, choosing a different activity instead.
- Reduce the likelihood or consequences of the risk event to an acceptable level.
- Share or transfer the risk to another third-party.
- Accept the risk rating (the cost may outweigh the benefits of treatment).If accepting the risk, consider ongoing monitoring.
Monitoring and revision
Risk management is an ongoing process, and requires monitoring and consistent reviews. Results should be recorded and reported both internal and externally – these should also add to the review of your risk management framework.
As you go through and review the risks, be sure to note any changes in their status. This could include changes caused by improved controls, identifying new risks, or control breaches.
The risk management framework should be reviewed periodically to ensure continuous improvement.